Folly threatens Japan's ecoonomy

TROUBLE is brewing over the yen. Opinions differ, but there is no serious debate on the issues surrounding the Japanese currency. Politics and economics are on a dangerous collision course.

For the past 20 years, few babies have been born in Japan. As a result the number of workers is falling. Naturally enough, with fewer workers, there is less scope for investment.

Japan has lots of people who are saving for retirement. Since opportunities at home are limited, much of these savings have to be invested abroad. Foreign investment must equal the current account surplus and so can grow only if the trade surplus expands. Last year it fell and Japan went into recession. For it to recover, the trade surplus must grow and the yen must weaken.

Sensible people in America know this. Larry Lindsey, George W Bush's economic guru, gave a key speech soon after the new US President was elected. He argued Japan could not recover without export growth. But US Treasury Secretary Paul O'Neill does not agree. He recently sounded off in Tokyo, saying that 'a falsely manipulated currency is a form of protectionist action'. Everybody has taken this as an attack on Japanese policy.

O'Neill is not everyone's hero. Alan Abelson, of market commentator Barron's, has remarked that he suffers from 'foot-in-mouth disease'. O'Neill in turn seems to have been angered by a comment from his opposite number. Japan's Finance Minister, Masajuro Shiokawa, told reporters the US Treasury Secretary had agreed that the market should determine exchange rates.

Shiokawa may have thought O'Neill would not object to private comments being made public when they expressed such an admirably free market sentiment. Now he knows better.

O'Neill is on shaky ground. Japan has not intervened in the foreign exchange market during the recent decline in the yen, as Vice Finance Minister Haruhiko Kuroda has made clear. The 'manipulation' to which the US Treasury Secretary refers must therefore be the words, rather than actions, of the Japanese. But if he objects to their comments, how does he justify his own? If theirs are manipulation, what are his? His foot seems to be, once again, in his mouth.

Behind the rash talk lies a fundamental problem. Economics calls for a large rise in Japan's trade balance - a fall in the yen is necessary to achieve it. But with the US in recession too, this reality is painful. This produces the classic reaction. When the answer is unpleasant, politicians take refuge in denial.

As the consequences of Japan's low birthrate are unpalatable, neither US nor Japanese politicians discuss them. This leads to absurd claims that 'reform' will produce economic recovery in Japan. This is, clearly, unadulterated nonsense. Japan suffers from a lack of demand and no reforms will increase that. Reform might improve supply, but that is not Japan's problem.

The failure of politicians to face facts threatens Japan's economy. It is the world's second largest, so we are all threatened by this political folly.